Accounts Receivables Aging

Why Should I Use Accounts Receivable Financing?

The most common question businesses ask when comparing lines of credit to Accounts Receivable Financing is “Why is this better than a line of credit”.

The short answer is that if often is not a better fit. If the business is profitable, well-established, has good financial reporting and an annual rate of growth of less than 10%-15%, the line is probably the best solution.

If however, the company does not meet these criteria, the question still remains “Why is this better than a line of credit”. Listed below are some of the reasons.

Growth

Are the growth opportunities the same with both types of lending? Typically the answer is no. Line sizes are usually smaller than with AR Financing and they usually carry a balance which reduces the cash availability.

A typical example might be a company that has a $100,000 line of credit with an average outstanding balance of $50,000. If the company has the opportunity to take on a $200,000 job and knows that the customer will not pay for 60 days, what can they do? If they have a line of credit, they can try to work with their bank to quickly increase the line or they can work with their suppliers to try to extend payment terms. If not, they need to just pass on the opportunity. If they have an AR Financing program in place, they can take the job without the constraints of cash flow. If the gross profit margin on the job is 25%, the additional profit for the company on just one job would be $50,000.

Supplier Discounts

Many suppliers offer quick pay discounts to their customers. If your business has those opportunities, you may often pass up the opportunity to take advantage of them because of cash flow concerns. To take money from your line of credit to take advantage of a discount may impede your ability to make payroll if one of your clients does not pay on time. With an AR Financing program, you can match cash to expenses and take advantage of the opportunities.

An example might be that your company buys $25,000 of supplies from a vendor every month. The vendor offers a 2% discount if the bill is paid within 10 days. You do not take advantage of the opportunity because you are trying to preserve your line. If, however, you took advantage of the opportunity every month, the total annual value would be $6,000 which flows directly to the bottom line. Wouldn’t it be good to have an additional profit at the end of the year of $6,000 just because you had the cash availability to take advantage of it?

Cost

Sometimes the response is that AR Financing is too expensive compared to a line of credit. Most AR Financing programs are based on a discount fee rather than an interest rate. It is difficult to compare a discount rate to the APR of an interest rate. The easiest way to compare is to look at the annual cost of both programs versus the annual value.

If Company XYZ does $1 million in annual sales and has a 25% gross profit margin and is comparing the two options, here are the results:

If they had a line of credit of $100,000 and they grow at 10% and has an average outstanding balance on the line of credit at 5%. The value looks like this:

Growth (100,000 X 10%) = $10,000
Cost (50,000 X 6%) = ($2,500)

Value = $7,500

With an AR Financing Program, the company has more cash availability and opportunity. Assuming the growth and discount opportunities from above and assuming a 60 day average collection period, here is the value:

Growth (100,000 X 10%) = $10,000
Additional Opportunity ($200,000 X 25%) = $50,000
Discount Opportunity ($300,000 X 2%) = $6,000
Cost ($1.3 million X 3%) = ($39,000)

Value = $27,000

While the AR Financing program is more expensive on an annual basis, the company has almost $20,000 in additional gross profit by using the program.

As the old saying goes, Cash is King!

For a lot of companies, an AR Financing program will help them run their businesses more profitably and effectively.